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Direct Payments on Behalf of Third Parties Policy Tax Liability of a State Agency Making Payments on Behalf of Third Party

IRC Code Section 3505(a) states "if a lender, surety or other person who is not an employer under such sections with respect to an employee or group of employees, pays wages directly to such employee or employees, such lender, surety, or other person shall be liable in his own person and estate to the United States in a sum equal to the taxes required to be deducted and withheld from such wages by such employer."

For State agencies, Code Section 3505(a) means your agency could be held liable for the employment taxes due on wages paid directly to a personal service provider on behalf of a third party, who is the actual employer of the personal service provider.

Avoiding Liability for Employment Taxes

To avoid liability under Section 3505(a) for employment taxes due on direct payments by a third party, you can do one of the following:

1. Enter into an agreement with the actual employer to act as the agent for the withholding and remittance of the employment taxes due on wages being directly paid by the agency. IRS Revenue Procedure 84-33, amplifying Revenue Procedures 80-4 and 70-6, sets forth the procedures to be followed by state and local health and welfare agencies wishing to act as agents under Section 3504 of the IRC, for welfare recipients who become the employers of individuals furnished by the agencies to provide in-home domestic service for welfare recipients. Please note, under certain circumstances agencies, other than health and welfare, could be assessed for not withholding the employment taxes due on amounts deemed wages paid directly on behalf of another party who is the common law employer of the recipient of the wage payments.
2. By reimbursing the employer and letting the employer make the wage payment directly to the personal service provider, you avoid any liability for the withholding of employment taxes due on the wage payment. The burden of withholding and remitting the taxes due on wages paid and the filing of applicable wage and tax reports is not canceled, but is shifted from your agency to the actual common law employer. Should you use this method to avoid possible tax liability, the consequence of this change should be reviewed for internal control problems that could occur. Also, IRS reporting requirements should be reviewed with the employer so that you are assured proper wage and tax reporting will take place.